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To aid recovery, interest rates being held at record low

Thursday, January 28, 2010

WASHINGTON (AP) — The Federal Reserve pledged Wednesday to hold rates at record lows to nurture the economic recovery and lower unemployment. But its decision drew a dissent from one member, signaling the Fed’s challenge in deciding when to pull back stimulus money it pumped into the economy.

The Fed’s statement sketched a mixed picture of the economy. Pointing to weakness, it noted that bank lending is contracting. And it dropped a reference in its previous statement to an improving housing market.

But on the positive side, the Fed said business spending on equipment and software seems to be rising. And it said economic activity “continues to strengthen.”

The Fed said it still expects to end a $1.25 trillion program aimed at driving down mortgage rates as scheduled on March 31. Yet it reiterated that it remains open to changing that timetable if necessary.

Reports on home sales this week pointed to a still-fragile housing market.

The Fed member who opposed the decision to retain a pledge to keep rates at record lows for an “extended period” was Thomas Hoenig, president of the Federal Reserve Bank of Kansas City. Hoenig said the economy has improved sufficiently to drop the pledge, which has been in place for nearly a year.

With the economy on the mend, the Fed this year can focus on how and when to pull back the stimulus money pumped out to fight the financial crisis. Fed Chairman Ben Bernanke will lead that effort now that his prospects for another four-year term have improved.

Bernanke and his colleagues will need to tread delicately. Reeling in the stimulus too soon risks short-circuiting the recovery, sending unemployment higher. If they move too late, they could unleash inflation.

Taking stock of the economy, Fed policymakers said the deterioration in the job market is easing and consumers are spending moderately. But they warned that double-digit unemployment, lackluster income growth and tight credit could crimp that spending.

Against that backdrop, the Fed kept its target range for its bank lending rate at zero to 0.25 percent, where it’s stood since December 2008.

In response, commercial banks’ prime lending rate, used to peg rates on home equity loans, certain credit cards and other consumer loans, will remain about 3.25 percent. That’s its lowest point in decades.

Super-low interest rates are good for borrowers who can get a loan and are willing to take on more debt. But those same low rates hurt savers. They’re especially hard on people living on fixed incomes who are earning measly returns on savings accounts and certificates of deposit.

In its statement, the Fed says it can keep rates low because inflation shouldn’t be a problem. It said “slack” in the economy — referring to factories operating at less than full throttle and the weak labor market — will prevent companies from jacking up prices.

Nonetheless, the Fed “sees the light at the end of the tunnel for the economy,” said Sung Won Sohn, economist at California State University. “Uncertainties in the economy have diminished.”